Cross Default

What is 'Cross Default'

Cross default is a provision in a bond indenture or loan agreement that puts a borrower in default if the borrower defaults on another obligation. For instance, a cross-default clause in a loan agreement may say that a person automatically defaults on his car loan if he defaults on his mortgage. The cross-default provision exists to protect the interest of lenders, who desire to have equal rights to a borrower's assets in case of default on one of the loan contracts.

BREAKING DOWN 'Cross Default'

Cross-default happens when a borrower defaults on another loan contract, and it provides the benefit of the default provisions of other debt agreements. Thus, cross-default clauses can create a domino effect in which an insolvent borrower may be in default on all his loans from multiple contracts if all lenders include cross-default in their loan documents. Should cross-default be triggered, a lender has the right to refuse more loan installments under the existing debt contract.

Occurrence of Cross-Default

Cross-default is caused by an event of default of a borrower on another loan. Default typically occurs when a borrower fails to pay interest or principle on time, or when he violates one of the negative or affirmative covenants. A negative covenant requires a borrower to refrain from certain activities, such as having an indebtedness to profits above certain levels or profits insufficient to cover interest payment. Affirmative covenants obligate the borrower to perform certain actions, such as furnishing audited financial statements on a timely basis or maintaining certain types of business insurance.

If a borrower defaults on one of his loans by violating covenants or not paying principal or interest on time, a cross-default clause in another loan document triggers an event of default as well. Typically, cross-default provisions allow a borrower to remedy or waive the event of default on an unrelated contract before declaring a cross-default.

Mitigating Factors for Cross-Default

When a borrower negotiates a loan with a lender, several ways exist to mitigate the effect of cross-default and provide room for financial maneuvering. For instance, a borrower may limit cross-default to loans with maturities greater than one year or over a certain dollar amount. Also, a borrower may negotiate a cross-acceleration provision to take place first before a cross-default, in which a creditor must first accelerate payment of principal and interest due before declaring an event of cross-default. Finally, a borrower may limit contracts that fall under the scope of cross-default, and exclude debt that is being disputed in good faith or paid within its allowed grace period.

RELATED TERMS
  1. Event Of Default

    An action or circumstance that causes a lender to demand full ...
  2. Acceleration Clause

    A contract provision that allows a lender to require a borrower ...
  3. Default Premium

    The additional amount a borrower must pay to compensate the lender ...
  4. Covenant

    A promise in an indenture, or any other formal debt agreement, ...
  5. Credit Crisis

    A crisis that occurs when several financial institutions issue ...
  6. Default Probability

    The degree of likelihood that the borrower of a loan or debt ...
Related Articles
  1. Markets

    Corporate Bonds and the Importance of Covenants

    Any type of investor, private or institutional, should be acquainted with the significance of covenants in corporate bond agreements.
  2. Investing

    What Happens in a Default?

    Borrowers are in default when they don’t honor a debt, whether their failure is intentional or not.
  3. Personal Finance

    Understanding Default Risk

    Default risk is the chance that companies or individuals will be unable to pay their debts.
  4. Investing

    Lending Clubs: Better Than Banks?

    If you need to borrow money and your credit is making it tough, this new option may be just what you're looking for.
  5. Markets

    What is a Loan Loss Provision?

    Banks set aside loan loss provisions to cover losses from bad loans.
  6. Investing

    What are the Five C's of Credit?

    The five C’s of credit are what banks and other lenders evaluate about a potential borrower when making a lending decision. The five C’s are Character, Capacity, Capital, Collateral and Conditions. ...
  7. Investing

    Understanding Covenants

    A covenant is a term placed in a loan that requires the borrower to either maintain or refrain from certain business activities.
  8. Personal Finance

    Financing Basics For First-Time Homebuyers

    If you're looking to get your first mortgage, there are many financing options available.
  9. Personal Finance

    Explaining Non-Recourse Debt

    Non-recourse debt limits a lender as to what it can and cannot pursue for collateral.
  10. Personal Finance

    Interest-Only Mortgages: Home Free Or Homeless?

    These loans can be beneficial, but for many borrowers, they present a financial trap.
RELATED FAQS
  1. What special powers does the government have to collect student loans?

    Contact student loan companies before student loans default, as the government has the power to get its money. Prior to default, ... Read Answer >>
  2. What are the differences between delinquency and default?

    Find out more about loan delinquency, loan default, and the difference between a loan borrower defaulting and being delinquent ... Read Answer >>
  3. What factors are taken into account to quantify credit risk?

    Learn how probability of default, or PD; loss given default, or LGD; and exposure at default, or EAD, are used to help quantify ... Read Answer >>
  4. What level of default rate is typical for the credit services industry?

    Learn how default rates affect businesses in the credit services industry, and what rates are considered normal for a company ... Read Answer >>
  5. Why do high profiting sales mitigate credit risk?

    Learn more about credit risk in loaning to individuals and businesses. Understand how credit risk is determined and the impact ... Read Answer >>
  6. Can Sallie Mae garnish my wages?

    Discover whether or not, and why, private lenders such as Sallie Mae have the ability to garnish a defaulted borrower's wages. Read Answer >>
Hot Definitions
  1. Bond Ladder

    A portfolio of fixed-income securities in which each security has a significantly different maturity date. The purpose of ...
  2. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  3. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  4. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  5. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  6. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
Trading Center